/ August 14 / Weekly Preview
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Monday:
N/A
Tuesday:
Retail Sales MoM (0.3% exp.)
Wednesday:
Building Permits (1.457M exp.)
FOMC Minutes
Thursday:
Initial Jobless Claims
Friday:
N/A
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Monday:
Monday.com MNDY
Tuesday:
Home Depot HD
Agilent A
Wednesday:
Cisco Systems CSCO
Juniper Networks JNPR
Illumina ILMN
Jazz Pharma JAZZ
LL Flooring Holdings LL
PENN Entertainment PENN
Roblox RBLX
Wendy's WEN
Thursday:
Walmart WMT
Applied Materials AMAT
Farfetch FTCH
Keysight Technologies KEYS
Friday:
Deere DE
Estee Lauder EL
Palo Alto Networks PANW
Stocks Weaken as Earnings Season Winds Down
The market continued to exhibit weakness in the past week, as most of the key earnings reports are in the history books and the all-important inflation numbers came in within expectations. Despite the pleasing CPI figures, the end result for equity investors was continued weakness, which doesn’t come as a surprise. Previously we stated:
“With sentiment amongst retail and professional investors sitting at “Extreme Greed” levels, we see a correction as more likely to occur than usual […] These conditions often align with short-term peaks in the market. Remaining patient and opportunistic with your allocation is likely to be rewarded, as there’s an increased chance we’ll get a better opportunity to “get on board”.
and
“This technical failure puts lower levels of support as targets for the completion of the corrective process, since resistance has now been confirmed.”
As expected, the market is continuing its corrective / consolidation process, with most of the driver components of the rally now reversing. The weakness we are now experiencing remains confined to the R1 and R2 levels, with SPY successfully testing the 50-DMA on Friday.
SPY Analysis
The MACD has turned sharply lower from an elevated level, suggesting the corrective process has legs; however, the OSMA divergence (red dashed line) is now wide enough to elicit a slight bounce;
For now, the market has done nothing wrong and the reversion in momentum we are experiencing is absolutely normal. Longer term, the trend remains entirely bullish, with SPY being able to clear the R2 level in its recovery from a technical downtrend. Historically, this suggests that in the following 12 months, we are more likely to register new highs rather than new lows.
As such, the corrective action remains a “buy-the-dip” style opportunity to increase exposure in portfolios. The only question that remains is exactly when to increase exposure and to what particular sector / factor.
In the chart below, we show the recent (200-day) performance for 3 key sectors: Tech (XLK), Industrials (XLI), and Energy (XLE). We have selected these in particular, as Tech has been the rally driver in 2023, and is the highest beta-to-SPY sector, Industrials have been performing in-line with SPY, while Energy has under-performed.
In the short term (next 2-3 months), we could expect these extremes in performance to converge. This would imply a further correction in XLK, and a further rally in XLE, which appears immune to the general drawdown in SPY. This thesis is confirmed by their individual technical charts.
Tech (XLK) is oversold, and is trading firmly below its 50-DMA. It has also recently triggered a medium term sell signal, which usually aligns with further corrective action. Given that tech stocks have had a blistering run in 2023, the current 7.4% drawdown appears too shallow to elicit buying interest from fundamental long term investors;
While XLK is sufficiently oversold to elicit a bounce in the short term (there is also immediate support at $165), we expect the correction to complete near the R1 level, at $155. Undoubtedly, this would also pressure SPY lower.
Energy, meanwhile, is experiencing a breakout, having had successfully tested the lower trend-line and S2 support. Energy appears immune to the current weakness in the main indices, and is not a main driver of SPY’s performance. We can assume strength in Energy will inversely correlate to SPY’s performance in the near term.
Factors and Timing
If Energy remains a momentum play and Tech represents a “buy-the-dip” opportunity, let’s explore the factors front to more accurately target specific stocks.
While large cap stocks are doing fine from a technical perspective, the same cannot be said for small and mid cap stocks. We were expecting these companies to start performing much better and catch up to their large cap counterparts, yet this outcome has eluded us so far.
The iShares Russell 2000 ETF (IWM) has recently failed to break out of its established range. There are fundamental and mechanical aspects that are working against smaller companies. As investors pour money into broad market ETFs, these flows disproportionately favor large caps. Moreover, smaller companies do not have the luxury of engaging in share repurchase programs in order to boost operating earnings. Instead, they rely on actual economic activity, which remains substantially weaker than headlines suggest, especially as the pandemic-era stimulus fades.
As we were expecting, however, the current corrective action is more pronounced in large caps, rather than mid and small. That is why the Z-Score divergence between SPY and the broad market (top 1000 stocks) is finally starting to close. What this means in practice is that following an unusual run, SPY is “catching down” to the average stock.
In terms of timing, we would like to see our automated strategies target equities as an asset class first and foremost. For now, the most underrated asset class and probably the far greater investment opportunity for the long term remains the treasury market.
With the stocks-bonds ratio hovering at extreme deviations, a broad rotation from equities to treasuries remains not only probable, but extremely profitable if it occurs. Bonds are currently very undervalued when compared to stocks. In the event of lower economic growth (not to mention a recession) the performance pickup in long dated treasuries will be significant.
Remember: interest rates are a function of inflation, economic growth, and debt. With rising debt levels, there is an absolute limit to where interest rates can rise, in order to keep debt service manageable. Over a longer timespan, the Fed will need to keep interest rates low in order to maintain economic stability.
The pressure will also come from governments and politicians, who cannot afford a defaulting economic cycle in the same vein of the Great Depression.
Our Trading Strategy
There are currently several technical opportunities in play, and one large fundamental prospect:
The pull-back in the S&P 500 is not complete, as of yet. There is still the prospect of tech stocks correcting further, which would put downside pressure on SPY. Large caps are especially prone to higher drawdowns, due to their previous out-performance which is now mean-regressing.
However, this represents a buying opportunity, due to the market’s overall bullish disposition. We are on the lookout for technical signals in order to add large-cap tech stocks to our live portfolio.
Energy, the loser of 2023, is riding back with a vengeance. It remains the preferred sector for momentum style positioning, and would represent an inflation hedge. We already own several Energy related names, and have recently added to this sector last week.
The fundamental investment opportunity is not in the equity space, but involves treasuries, which are historically cheap relative to stocks. Given the 10-year yield is at 4.17%, an investor is handsomely rewarded risk-free to wait for capital appreciation. Technical downside is also minimal, so we are waiting for the right signal to add to treasuries exposure as well.
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